The Economic Growth and Tax Relief Reconciliation Act of 2001, and the Jobs and Growth Tax Relief Reconciliation Act of 2003, are the two pieces of legislation that are commonly referred to as the Bush tax cuts. They offer different forms of relief to most taxpayers in this country, and have been getting plenty of attention in the media as pressure mounts on Congress to either extend the tax laws, or let them expire at the end of the year. However, reporters and bloggers are focusing on the effect these cuts have had on small business owners specifically, as unemployment problems continue to hinder economic recovery.
Tax Rates and Incentives
The two pieces of legislation from the early 2000’s had a handful of effects on U.S. tax law. They reduced the “marriage penalty,” provided incentives to parents and low income working Americans, and also increased credits for education and retirement saving accounts. Most importantly, however the cuts reduced tax rates across the board. The Economic Growth and Tax Relief Reconciliation Act created six tax brackets based on income level (10%, 15%, 25%, 28%, 33%, and 35%). If the laws expire, the 10% bracket would disappear, and the brackets would revert back to 15%, 28%, 31%, 36% and 39.6%. This would represent an increase for nearly all Americans who pay taxes. Additionally, changes to itemized deduction phase outs could eliminate up to 80% of deductions for higher income taxpayers.
Capital Gains and Qualified Dividends
The 2001 and 2003 tax cuts also reduced the maximum tax rate on capital gains and qualified dividends from 20% to 15%. If allowed to expire, the top capital gains rate would return to 20% and qualified dividends would be taxed at the same rate as a taxpayer’s income, or up to 39.6%.
Looming Expiration
Unless extended, the Bush tax cuts are scheduled to expire at the end of the year. If Congress fails to act before they take their winter break, then the tax rates will automatically revert to what they were in 2000. Some experts are asserting that extending all of the cuts would provide a temporary economic stimulus, however the Congressional Budget Office asserts doing so would only have a slight impact on the economy. Others are warning that letting all the tax cuts expire could hurt small business owners, and hinder job creation.
Obama's Proposal
Instead of choosing to extend the cuts, or let them all expire, the White House has proposed a compromise. President Obama would like to extend all of the cuts for low and middle income Americans, while letting the cuts that impact taxpayers making over $200,000 ($250,000 for joint filers) expire.
Small Businesses and Job Creation
One of the most confusing aspects of the Bush tax cuts is how they will affect business owners, and the ongoing unemployment problem in this country. Many conservative experts have argued that even letting only the cuts that affect high-income taxpayers would hurt the recovering economy. Senator Orrin Hatch even said that allowing the cuts to expire would amount to "a job-killing tax hike on small business during tough economic times."
This statement is somewhat misleading. We can assume that a business owner making over $200,000 does not own a mom-and-pop store in a struggling neighborhood. Although 24% of taxpayers report some income from a business, only about 2.5% of Americans – or 900,000 taxpayers – would be affected Obama’s proposal. However, that 2.5% reports an estimated $400 billion in income, or nearly 44% of all business income in the country.
Impact on Larger Businesses
It is also important to note that there are over half a million taxpayers in the country who report business income over $700,000. These taxpayers would be significantly impacted by Obama’s proposal to let some of the Bush tax cuts expire. In addition to an increased income tax rate, they would also be hurt by capital gains tax increases, and the new deduction phase-outs. Although not technically small business owners, these doctors, investors, or successful owners of multiple franchise locations, employ a number of taxpayers.
Unemployment Problems
Although it is easy to review statistics from the IRS regarding income levels, it is difficult to predict exactly what impact the tax cuts have on job creation and unemployment. Some claim that any additional taxes would stop a business owner from hiring more employees. Others argue that the revenue from letting some cuts expire would lead to less government borrowing, and a better economy where small business credit is more easily accessible.
Federal Revenue
If Congress went with President Obama’s proposal and passed legislation allowing the Bush tax cuts to expire for taxpayers earning over $200,000 ($250,000 for joint filers), this it could generate an estimated $1.5 trillion in federal revenue over the next 10 years.
Future of the Bush Tax Cuts
When Congress returns after Labor Day, they will have a hand full of tax issues to consider, including the Bush tax cuts. However, with elections in only a few months, there is a lot of pressure on members of Congress to act a certain way. With the Democratic Party fighting to keep their majority, we might see a politically motivated compromise designed to please taxpayers.